The sun is seen behind a crude oil pump jack in the Permian Basin US
The crunch comes as output cuts made by the Saudis and others in the OPEC are finally having an impact. Image Credit: Reuters

Betting on a tighter oil market has been a bad trade for most of this year. But there are signs it’s finally paying off.

After languishing for months, crude surged above $80 a barrel in London last week as fuel demand in China and elsewhere recovers from the pandemic to reach new highs. That’s happening just as production cutbacks by Saudi Arabia and its OPEC+ allies are set to rapidly drain storage tanks around the world.

“We’re expecting a sharp tightening of the market,” Toril Bosoni, head of oil markets at the International Energy Agency in Paris, said in an interview with Bloomberg television. “As demand increases seasonally, we do think there’s a risk that prices will continue to increase into the third quarter.”

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Besides rewarding bullish traders, that would boost energy producers from Texas to Moscow. It would also endanger the global economy, which has benefited recently from easing fuel costs and cooling inflation.

It’s still far from clear whether Brent crude’s return to $80 a barrel is a turning point that heralds a major price rally. Economic storm clouds still darken the horizon, from shaky Chinese indicators to rising interest rates, and barrels of cut-price crude continue to flood from Iran and Russia.

But at the very least, the market appears to have found a floor.

Oil-watchers spent the first half of the year lowering their price expectations. They abandoned initial calls for a return to $100 a barrel in the face of lackluster economic growth, even as Saudi Arabia made repeated efforts to juice prices with production.

Yet analysts held onto the view that the coming six months would deliver a stronger market, and last week the pieces began falling into place. Brent futures, the main international benchmark, soared to the highest since May.

“It is the tipping point the market was expecting,” said Jorge Leon, senior vice president of oil market research at consultant Rystad Energy A/S. “It looks like the start of the hot summer in the crude market.”

OPEC+ cuts

The crunch comes as output cuts made by the Saudis and others in the Organization of Petroleum Exporting Countries are finally having an impact.

Price differentials for crude grades chemically similar to those shipped by Riyadh are climbing in the cargo market. The kingdom gave markets another boost last week by announcing that an extra, unilateral cut of 1 million barrels a day launched this month would continue into August.

Even Russia, after much delay, appears to be playing a part. For much of this year, Moscow was boosting crude exports and maximising sales, even as it was pledging to cut production. Tanker tracking data compiled by Bloomberg shows that, in the four weeks to July 9, the country pared exports by roughly 25 per cent.

The balance of supply and demand already swung from surplus to deficit in June, according to Standard Chartered Plc. The shortfall will more than double in coming months, draining oil inventories by a hefty 2.8 million barrels a day in August, the bank estimates.

“All the micro-fundamental factors are finally turning bullish,” said Trevor Woods, chief investment officer at commodities hedge fund Northern Trace Capital LLC. “I mean, these draws are gonna be huge.”

Skeptical banks

Many oil traders are still skeptical about the prospects of a price surge.

Demand remains at the mercy of an uncertain economic environment, from contracting Chinese manufacturing to sluggish growth in Europe and fears that rising US interest rates could trigger a recession. Last week, the IEA trimmed forecasts for world fuel consumption this year.

On the supply side, output is climbing from the US to Brazil and Guyana. Even within OPEC+, members such as Iran and Venezuela, exempted from making production cuts, are ramping up oil sales. Tehran’s exports have reached a five-year high, according to consultant Kpler Ltd.

Some of the Wall Street forecasters who once predicted $100 crude are darkening their outlook. JPMorgan Chase & Co. contends that OPEC+ will need to slash output further, while Morgan Stanley sees the market back in surplus next year.

“Much depends on demand,” said Martijn Rats, Morgan Stanley’s London-based global oil strategist. “But supply seems to be there to meet it.”

Even so, plenty of market watchers see significant upside. And, of course, the most powerful actor in the oil market is on that side of the bet.

Saudi Arabia, which needs ample oil revenue to fund Crown Prince Mohammed bin Salman’s plans for economic and social transformation, has said it will do whatever is necessary to keep the oil market in balance and could further prolong its voluntary cuts.

“Barring an abrupt macroeconomic slowdown, the stars are aligning for a zesty crude price rally” to $90 a barrel, said Bob McNally, president of Washington-based consultants Rapidan Energy Group and a former White House official.